It’s my annual Taxes from A to Z series! If you’re wondering how to figure basis for cryptocurrency or whether you can claim home office expenses during COVID, you won’t want to miss a single letter.
K is for Kiddie Tax.
If you have an excellent memory, you might recall that I also used K for Kiddie Tax last year. And normally, I don’t like to repeat a letter in the series. So, what gives? Changes in the law.
The Tax Cuts and Jobs Act made a fairly unpopular change to the kiddie tax, marking unearned income to be taxed at the rates paid by trusts and estates. Those rates can be as high as 37%. And while that sounds the same as for individuals, it’s not. Tax rates for trusts and estates “climb the brackets” faster than individuals which means that since the rates are compressed, you hit the top rate much sooner.
However, in 2019, Congress passed the Setting Every Community Up for Retirement Enhancement Act or the Secure Act. The Secure Act effectively repealed the kiddie tax bits of the TCJA, meaning that the kiddie tax was returned to the way it was in 2017 (did you get all that?).
The effective date for the new rules – which are really the old rules – is supposed to begin with the 2020 tax year, but you can elect to have it apply to the 2018 and 2019 tax years.
Here’s what you need to know:
- Earned income, or income from wages, salary, tips, or self-employment, is not subject to the kiddie tax. That income is taxed under the normal rules.
- The kiddie tax applies to unearned income. Unearned income typically means investment income like dividends, capital gains, and interest; those amounts are subject to the kiddie tax. If your child is under the age of 19 (or under the age of 24 and a full-time student), the kiddie tax applies once unearned income hits $2,200 (for the 2019 tax year). If that’s the case, your child has unearned income subject to the kiddie tax and must file a federal form 8615, Tax for Certain Children Who Have Unearned Income (downloads as a PDF). But if your child’s only income is interest and dividend income (including capital gain distributions) and totals less than $11,000, you may be able to elect to include that income on your own return rather than file a return for your child. See Form 8814, Parents’ Election To Report Child’s Interest and Dividends (downloads as a PDF).
- The kiddie tax is largely figured as gross income less deductions. For 2019, the standard deduction amount for an individual who may be claimed as a dependent by another taxpayer cannot exceed the greater of $1,100 or the sum of $350 and the individual’s earned income, but not an amount which exceeds the regular standard deduction amount ($12,200). For 2020, the numbers are largely the same except that the regular standard deduction amount is $12,400.
So, with all of that, how do you calculate the tax? Here’s the formula:
Child’s net earned income + child’s net unearned income – child’s standard deduction = child’s taxable income
- A child’s net earned income is taxed at the regular rates for a single taxpayer; and
- A child’s net unearned income that exceeds the unearned income threshold ($2,200 for 2019) is subject to the kiddie tax and is taxed at the parents’ rates.
Keep in mind that these rules apply to children who are dependents. Those who are not dependents because of their age or filing status (such as children who are married), level of support or those who are emancipated have a different set of rules. Other exceptions may apply: for example, children with earned income totaling more than half the cost of their support are not subject to the kiddie tax rules.
Again, the rules can be complicated depending on your specific facts and circumstances. If you’re still scratching your head, be sure to consult with your tax professional.
You can find the rest of the series here: